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Oracle Remains Neutral

We are maintaining our Neutral recommendation on Oracle Corp (ORCL) after the company reported better-than-expected second quarter results, primarily driven by strong new software license sales and stringent cost control. However, the decline in hardware revenue continued for the company.

Going forward, lower hardware volumes remain a concern. As Oracle sells higher-margin products compared to its competitors, we anticipate that a sluggish market may act as a headwind for hardware volume.

Moreover, Oracle is a late entrant in the cloud computing space and thus is trying to gain traction in the segment through aggressive acquisitions. The company is paying a premium value for these assets in order to catch up with the dominant players like salesforce.com (CRM) and International Business Machines Corp (IBM). We believe that these acquisitions come with certain integration issues and may not perform as per company expectations, which will eventually hurt profitability going forward.

As of November 30, 2012, the company had an aggregate of $19.8 billion outstanding notes payable (including the current portion) compared with $14.8 billion as of May 1, 2012. The company currently has $1.25 billion due for repayment in fiscal 2013. Most recently, Oracle raised $5.0 billion in debt, which has further leveraged the balance sheet.

Oracle enjoys a dominant position in the enterprise software and database management system market and higher spending on enterprise IT will positively impact the company. According to market research firm Gartner, worldwide enterprise IT spending is expected to increase 2.5% year over year to $2.68 trillion in 2013.